Economics for Firms
Autor: Max Yu • February 28, 2016 • Coursework • 1,275 Words (6 Pages) • 634 Views
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BUS 525 ECONOMICS OF THE FIRM
Group 5 Homework #1
Submit to: Gonyung Park, Ph.D.
By Group members:
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Homework #1
Q.1 (20 points) Sandra and Naomi are considering to open up a new business together. To do that, they have to give up their current jobs, in which Sandy is making $60,000/year and Naomi is making $80,000/year. The new business is expected to generate $500,000 revenue per year with $300,000 cost per year. Sandy presented a proposal to split $200,000 profit equally between herself and Naomi. Naomi said it is unfair.
(1) Why do you think Naomi said that? In answering the question, you need to make a clear reference to economic profit and accounting profit.
Answer:
Naomi said Sandy’s proposal is unfair because Sandy merely consider accounting profit, but didn’t take economic profit take into account.
Generally, Naomi and Sandy’s new business is successful to make profit, according to accounting profit definition, however, when they estimate economic profit individually, the result would be same because of differ opportunity cost.
In term of economic profit, both explicit and implicit cost must take into account, thus, in this case, Naomi’s implicit cost is $80,000, (because he has to give up $80,000/year job to start new business), his economic profit is $20,000 compare to Sandy’s economic profit is $40,000 which calculated in the same way.
Therefore, Naomi feel unfair because he spend more opportunity cost than Sandy, but earn less economic profit.
(2) For three possible annual revenues, $400,000, $500,000 and $600,000, construct a profit-sharing plan in which the economic profit (or loss) for Naomi and Sandi are the same with each other.
According to different annual revenues, accounting profit on each annual revenue showing as:
Explicit cost | Accounting profit | |
Annual revenues $400,000 | $300,000 | $100,000 |
Annual revenues $500,000 | $300,000 | $200,000 |
Annual revenues $600,000 | $300,000 | $300,000 |
Because the profit generated by new business will be split equally to Naomi and Sandi, the follow chart shows their economic profit respectively.
Name | Split accounting profit | Implicit cost | Economic profit | |
$400,000 | Sandy | $50,000 | $60,000 | -$10,000 |
Naomi | $50,000 | $80,000 | -$30,000 | |
$500,000 | Sandy | $100,000 | $60,000 | $40,000 |
Naomi | $100,000 | $80,000 | $20,000 | |
$600,000 | Sandy | $150,000 | $60,000 | $90,000 |
Naomi | $150,000 | $80,000 | $70,000 |
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